Monetary and Fiscal Policies Causing Financial Crisis

Macroeconomics
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The financial crisis began in 2007. This was because the Federal reserve shifted its concern from inflation to financial stability. It later spread to other economies especially in advanced economies due the direct exposure to subprime assets, loss of confidence in a number of asset classes, and drying-up of the wholesale financial markets CITATION Mer101 \l 1033 (Merrouche & Nier, 2010). Through such mechanisms, it exposed "home-grown" imbalances in finance in advanced economies that were characterized by relying heavily on wholesale funding sources by banks and bubbles of assets in the real estate market. The causes of the crisis are deep rooted with varying views on its causes CITATION Mer101 \l 1033 (Merrouche & Nier, 2010).
Adrian & Shin (2008) lament that research finding have revealed that monetary policy had a hand in the global financial crisis. Policy rates at the time were maintained at a very low rate for prolonged period CITATION Mer101 \l 1033 (Merrouche & Nier, 2010). Therefore, this reduced the cost of wholesale funding for intermediaries, caused banks to take liquidity and credit risks, and increased the supply and demand of credit inform of mortgages that raised prices of assets (housing) CITATION Mer101 \l 1033 (Merrouche & Nier, 2010).
De Nicolò et al. (2010), on the other hand, proposed a "risk-shifting" channel through which monetary policy caused the financial crisis. To them low short rates effect on "risk-taking" are ambiguous and propose the opposing "risk-shifting" channel CITATION Mer101 \l 1033 (Merrouche & Nier, 2010). Here, the persistent low policy rates are linked with reduced risk taking as these low short rates profits and intermediation margins that in turn reduce incentives for risk taking among the intermediaries CITATION Mer101 \l 1033 (Merrouche & Nier, 2010).
The function of the fiscal policy was to maintain economic stability through economic automatic stabilizers. Discretionary fiscal policy taken on a case-by-case basis was to be avoided and be rule-based CITATION Ben13 \l 1033 (Benner, 2013). The government budget was to be balanced or indicate a surplus. These automatic stabilizers contributed to the increasing gap between tax revenues and public expenditure. This was due to the shift from focussing on inflation to the focus on stabilization CITATION Ben13 \l 1033 (Benner, 2013).
In recessions, the typical response by Central Banks is through monetary policies. For example, the interest rates in the United states were lowered. As mentioned above, fiscal policies rely on automatic stabilizers CITATION Car121 \l 1033 (Carvalho, Eusepi, & Grisse, 2012). That is, fiscal deficits increase with a fall in tax revenues and rise social safety net outlays. Contrary to this, the severity of the 2007-08 financial crisis required complementation of the conventional responses with other aggressive approaches, for example, expanding central Bank's balance sheet and fiscal policies to be placed CITATION Car121 \l 1033 (Carvalho, Eusepi, & Grisse, 2012).
The United States increased Central Bank balance sheets to reflect policy measures with different goals and channels of transmission. ...